CDAE 254 - Class 14 Oct. 11
4. Market demand and elasticities
Class exercise
4. Market demand and elasticities
Review for the midterm exam
Quiz 4 (Chapter 4)
Midterm exam
Pick up your quiz 4 anytime after 1:00pm, Oct. 12
Answer key to problem set 4 will be in the website …
Midterm exam: Tuesday, Oct. 16

This problem set will not be collected and answer key will be posted in the website before the midterm exam .
Six problems:
4.1., 4.2., 4.4., 4.6., 4.7., and 4.8

4.1. Market demand curves
4.2. A general definition of elasticity
4.3. Price elasticity of demand
4.4. Income elasticity of demand
4.5. Cross-price elasticity of demand
4.6. Empirical studies of demand
4.7. Applications

4.4. Income elasticity of demand
(1) What is income elasticity of demand?
The percentage change in the quantity demanded of a good (Q) in response to a 1% change in income.
e
Q , I

Percentage change in Q
Percentage change in I


Q
Q

I
I


Q

I

I
Q

4.4. Income elasticity of demand
(2) Range of income elasticity of demand:
< 0 inferior good
< 1 inelastic
= 1 unit elastic
> 1 elastic
(3) An example:
When the average monthly income increased from $2000 to $2200, printer demand increased from 100 to 125. What is the income elasticity of demand for printer?

4.4. Income elasticity of demand
(4) Another example:
Q = 200 + 0.005 I - 0.02 P where Q = demand for computer
I = average income
P = average price
What is the income elasticity of demand when the average income is $30,000 and the average computer price is $1,500?

4.6. Cross-price elasticity of demand
(1) Definition: The percentage change in the quantity demanded of a good (Q) in response to a 1% change in the price of another good.
e
Q i
, P j

Percentage change in Q

Percentage change in P j

Q i
Q i

P j


Q i

P j

P
Q i j
P j i

4.6. Cross-price elasticity of demand
(2) How to calculate cross-price elasticities?
(1) When we have two observations: e.g., the demand for pork increased from 100 to 110 when the price of beef increased from 3 to 3.6, what is the elasticity of pork demand with respect to beef price?
(2) When we have a demand function: e.g., Q pork
= 40 - 2 P pork
+ 0.5 P beef
What is the elasticity of pork demand with respect to beef price when the pork price is 4 and beef price is 6?

Class Exercise
(Tuesday, Oct. 9)
For demand function Qc = 300 – 0.3Pc – 0.1Pp + 0.05 I , where
Qc is the demand for laptop computers in a market, Pc is the average price of laptop computers, Pp is the average price of printers and I is the average income. If we know the average laptop computer price is $800, the average printer price is $100 and the average income is $20,000, calculate:
(1) the income elasticity of demand for laptop computers:
(2) the own-price elasticity of demand for laptop computers:
(3) the cross-price elasticity of demand for laptop computers with respect to the average price of printers.

4.7. Empirical studies of demand
(1) Examples of estimated demand elasticities
(2) Estimation of demand functions (regression analysis)
(3) How to estimate demand elasticity from demand equation?
(4) Elasticity matrix (e.g., demand for animal products in urban China)

Marshallian price elasticity of good i with respect to good j
Pork
Expenditure
Elasticities
Marginal
Budget % Pork
0.8327
B & M 0.8492
Poultry 1.4895
Eggs 0.9858
Fish 1.1909
39.14
7.26
17.11
14.00
19.99
B & M Poultry Eggs Fish Milk
-0.8503
-0.1305
0.0876
0.0844
-0.0130
-0.0227
-0.7002
-0.6745
0.0907
0.2301
0.1736
0.0717
0.0549
0.0092
-1.3362
-0.5057
0.2939
-0.0068
0.2380
0.1281
-0.3448
-0.7766
-0.1902
0.0132
Milk 1.2689
0.0250
-0.2067
0.0544
0.2337
-0.2000
-1.0253
-0.0629
-0.8070
0.2608
-0.0303
0.0281
-0.5703
-0.2884

Chapter 4: Review questions
(1) What is a market demand function (curve) and how to draw it from individual demand curves?
(2) How does a change in income or the price of another commodity shift a market demand curve?
(3) What is the general definition of elasticity and how to calculate it and how to interpret it?
(4) How to calculate a price elasticity from (a) two observations and
(b) a demand function?
(5) What is the relation between price elasticity and total revenue and
(market share)?
(6) How to calculate an income elasticity from (a) two observations and (b) a demand function?
(7) How to calculate a cross-price elasticity from (a) two observations and (b) a demand function?
(8) How to examine the relation between two commodities according to their cross price elasticities?

1. What will be covered in the exam?
2. What will be the format?
3. What are the study materials and practice problems?
4. What do you need to bring to the exam?
5. Suggestions

1. What will be covered in the exam?
-- Chapter 1 -- Chapter 4
-- Approximate distribution:
Chapter 1
Chapter 2
Chapter 3
Chapter 4
10 - 15%
25 - 30%
25 - 30%
30 - 35%

2. What will be the format?
-- Multiple-choice questions (about 45-50 points)
(e.g., interpretation of an income elasticity of 0.4)
-- Problems (about 25 - 35 points)
(e.g., calculate a demand elasticity)
-- Graphical analysis (about 15 - 25 points)
(e.g., draw a demand curve and estimate CS)

3. What are the study materials and practice problems ?
Quiz 1 to Quiz 4
Class exercises
Class examples
Lecture notes (class 01 -- class 14)
Problem sets
Textbook (Chapter 1 to Chapter 4)

4. What do you need to bring to the exam?
-- Your calculator
-- A ruler will be helpful
-- No formula sheet is needed

5. Suggestions a. Go over each quiz and make sure you understand and know how to answer every question in every quiz b. Go over each class exercise and make sure you understand and know how to answer every question c. Go over the lecture notes, especially for the classes you missed d. Go over your problem sets and Chapters 1-4 of the textbook e. Study hard and feel confident!